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This is a novel legal theory. Goldman is being sued because they did not disclose that people on the opposite side of a trade had opposing opinions. Basically,

This is a novel legal theory. Goldman is being sued because they did not disclose that people on the opposite side of a trade had opposing opinions. Basically, they facilitated a transfer of wealth from the stupid to the smart, and now they're getting punished. If Goldman made some kind of material misstatement about the quality of the products, that's a different matter. But so far, there's no indication of that. They helped execute a deal between two consenting, informed parties; suing them is like suing a condom manufacturer because they facilitated the one-night stand that turned into an unpleasant relationship.

apsec112 17y ago
No, that's not the problem. The problem is that the mortgage securities were, in large part, designed by people who would benefit if they failed. It's like selling someone a lock that was designed by burglars.
- jamiequint 17y ago
  Thats the definition of any zero sum bet though. Puts are also designed by people who will benefit if stocks drop in price, that doesn't necessarily make it wrong or bad. The counterparties had access to all the same info Paulson & Co. did, they just didn't analyze it correctly or in as much detail.
  - apsec112 17y ago
    The key difference between the two is that the idea behind a put is extremely simple, while the ideas behind a mortgage-backed collateralized debt obligation are extremely complex. Hence, a counterparty to the put could be reasonably expected to know what they are getting into, while the same does not apply in the Goldman Sachs case.
    - yummyfajitas 17y ago
      As we all know, hedge funds, pension funds and investment banks are completely unable to evaluate complex investments. Note: CDO's are not sold to retail investors.
    - jamiequint 17y ago
      If you buy something you don't understand (when all the info is clearly available to you) its your own damn fault. The organizations buying this stuff were required to have ISDA contracts (not easy to get). Their money is managed by professionals. If you want a place to put blame the most apt place would be Fitch, Moody's and Standard and Poors. The ratings agencies were far more complicit in perpetuating false understanding than GS was.
      - apsec112 17y ago
        "If you buy something you don't understand (when all the info is clearly available to you) its your own damn fault." Suppose I sell you a word processing program. Inside the program, I include a snippet of code that will cause the program to stop working in thirty days, without telling you anything about it. By your logic, you would not be within your rights to demand a refund, since it is "your own damn fault" that you didn't understand the ten megabytes of assembly code that I sold you.
        jamiequint 17y ago
        That analogy doesn't work. They were selling bonds to financial professionals, who had to have complicated ISDA agreements to even enter into these purchases. Part of their job is to analyze the assets they are buying. Its reasonable to expect them to do so.
      - btilly 17y ago
        Read the complaint again. Goldman Sachs failed to disclose Paulson & Co's role, and then actively lied to investors about Paulson & Co's net position in the deal. This is material information that was not available to investors in the CDO. Hence the complaint. Edit Got the players wrong. Fixed.
      - jamiequint 17y ago
        @btilly (won't let me reply directly to your comment) I realize what you're saying is true, but most of the arguments being made are about being made about whether the trade itself (under normal circumstances) were unethical, I'm trying to counter those.
  - btilly 17y ago
    The counterparties had access to all the same info Paulson & Co. did, they just didn't analyze it correctly or in as much detail. You have to separate issues here. Paulson & Co. were counterparties on a credit default swap with Goldman Sachs. That is fine. Goldman Sachs failed to disclose information to investors about Paulson & Co's role, and lied about their position. That is what the SEC is upset about. You are right that the credit default swap was a zero sum bet between equally informed counterparties. It so happens that one side analyzed the deal better. (Actually that is questionable. The bankers on the Goldman Sachs side knew that they would get large personal bonuses no matter what happened to Goldman Sachs. So they may have analyzed it correctly and done what was in their best interest. But let's not get into perverse incentives.) The issue that the SEC has with the scenario is that not only did Goldman Sachs fail to disclose Paulson & Co's involvement (instead saying that ACA had selected all of the bonds), they told investors that Paulson & Co had $200 million in equity in the deal, without disclosing the credit default swap position that meant Paulson & Co were actually significantly net short. This was a lie, and that is why Goldman Sachs is in trouble here. Edit I had the parties wrong. Fixed.
    - jamiequint 17y ago
      OK, yes there was clear misrepresentation of who put together the CDO, that seems to be obvious from the available information. What I just don't see is why it that is material. By nature of buying a Synthetic CDO the buyers had to know someone was short, why should it matter who it was? They should have been buying based off the assets in the investment not based off of the counterparty.
      - dandelany 17y ago
        > By nature of buying a Synthetic CDO the buyers had to know someone was short, why should it matter who it was? Because the party who was short on the product was the same party who created the product, and Goldman did not inform investors of this fact. It's not a matter of just buying and selling. The RMBS's underlying the CDO were packaged by a party who had significant interest in seeing the package blow up. An Oversimplified Analogy: Imagine that I come to you and say, "I have a document that represents 100 mortgages and I'd like to broker a sale. If you buy this document, as long as less than ten of these mortgages go into default, you make money. If more than ten of them go into default, your counterparty in the sale (not me) will make money." "Okay," you say, "that sounds interesting. So where did all these mortgages come from?" "Oh, we got an independent company to pick a bunch of mortgages that they consider fairly safe and that they believe are a good representation of the overall U.S. mortgage market." "Great!" you say, and you buy a billion dollars worth. More than ten mortgages end up defaulting and you lose a shit ton of money. Imagine your dismay when you learn that the mortgages were not packaged by some third party as I claimed, but hand-picked by the very counterparty you were betting against. OBVIOUSLY if they were going to benefit from more than ten mortgages defaulting, they would have filled the entire document full of mortgages they expected to fail! This is fraud in its most basic form!
- byrneseyeview 17y ago
  So? When buyers push a deal, they design it so it's underpriced. When sellers push a deal, they want it overpriced. In other words, everyone is in this market to profit. You're acting like the motives are criminal, here. But if two people take opposite sides of the same trade, they will both have the sinister motive of picking the other side's pocket. That's why there's a big, detailed disclosure agreement. You can read it right here: http://tinyurl.com/y7rnyh3 http://tinyurl.com/y7rnyh3 . The lock/burglar analogy is flawed, because stealing destroys wealth. Inefficient asset allocations destroy wealth, and asset allocations can only be efficient when people with the same data and different interpretations are able to trade.
lhuang 17y ago
The SEC alleges that GS committed fraud by not informing investors that the "3rd party objective manager" who cherry-picked the assets that were packaged in the CDO was at the same time betting against the very assets he picked. That, and recorded conf calls show that GS analysts as trying to convince rating agencies to inflate the ratings of the underlying assets in the CDO.
- nearestneighbor 17y ago
  > That, and recorded conf calls show that GS analysts as trying to convince rating agencies to inflate the ratings of the underlying assets in the CDO. What happened to winking, nods and understanding looks on golf courses?
- byrneseyeview 17y ago
  That's just plain stupid. If you're buying, don't count on the seller having your interests at heart. That's part of Goldman's job. They want the transaction to happen; if they can get a good rating, they should. The entity that's responsible for making the rating agencies rate things well is... the rating agency.
  - deleted 17y ago
    [deleted]
  - dandelany 17y ago
    There is a massive difference between expecting the seller to have your best interest at heart, and expecting that the seller will give you accurate information regarding what product they are selling you. The first is naivete. The second is Federal securities law.
billjings 17y ago
If this is indeed similar to the ProPublica report (referenced in another post in this thread), then this isn't a case of someone in the "opposite side of a trade". The trade would not have existed without the hedge fund committing to buy the worst parts of it - the party buying the worst tranche was called the "sponsor" for a reason. Not only that, but the sponsor wasn't short on just their portion of the trade. They were short on the entire CDO. They've got a bet that pays off if you crap out. Without that bet, you don't even get the prospectus - you don't even know about the security in the first place. I recommend reading the ProPublica article.
- byrneseyeview 17y ago
  I've read the ProPublica article. This is even more of a stretch. Deals exist when there is demand on both sides. There can only be demand for both sides of the deal when there's disagreement about how the deal will perform. Goldman is being sued because one of their customers was right, and one of their customers was wrong. If the mortgage bubble had not collapsed, would credit default swap sellers and CDO buyers be penalized for profiting from the shorts' demise?
  - siavosh 17y ago
    The issue wasn't a disagreement in valuation, this is totally valid as you point out. The fraud allegation is because they were an advisor to their clients, and supposedly they misrepresented the valuation of products when then knew the value was something else.
  - billjings 17y ago
    If they had misrepresented their deal, then yes. If Goldman Sachs lied about matters material to the valuation of the deal then they've committed fraud.
  - prodigal_erik 17y ago
    Deals also exist when the parties have different risk tolerances or time preferences for money. If I sell you my car because I need a down payment for a condo, that doesn't mean I think the car isn't actually worth what you're paying. If I know it isn't worth what you're paying because evil mechanics swapped all the working parts with bad ones, and I hide that from you, that's fraud.

apsec112 17y ago

No, that's not the problem. The problem is that the mortgage securities were, in large part, designed by people who would benefit if they failed. It's like selling someone a lock that was designed by burglars.

jamiequint 17y ago
Thats the definition of any zero sum bet though. Puts are also designed by people who will benefit if stocks drop in price, that doesn't necessarily make it wrong or bad. The counterparties had access to all the same info Paulson & Co. did, they just didn't analyze it correctly or in as much detail.
- apsec112 17y ago
  The key difference between the two is that the idea behind a put is extremely simple, while the ideas behind a mortgage-backed collateralized debt obligation are extremely complex. Hence, a counterparty to the put could be reasonably expected to know what they are getting into, while the same does not apply in the Goldman Sachs case.
  - yummyfajitas 17y ago
    As we all know, hedge funds, pension funds and investment banks are completely unable to evaluate complex investments. Note: CDO's are not sold to retail investors.
  - jamiequint 17y ago
    If you buy something you don't understand (when all the info is clearly available to you) its your own damn fault. The organizations buying this stuff were required to have ISDA contracts (not easy to get). Their money is managed by professionals. If you want a place to put blame the most apt place would be Fitch, Moody's and Standard and Poors. The ratings agencies were far more complicit in perpetuating false understanding than GS was.
    - apsec112 17y ago
      "If you buy something you don't understand (when all the info is clearly available to you) its your own damn fault." Suppose I sell you a word processing program. Inside the program, I include a snippet of code that will cause the program to stop working in thirty days, without telling you anything about it. By your logic, you would not be within your rights to demand a refund, since it is "your own damn fault" that you didn't understand the ten megabytes of assembly code that I sold you.
      - jamiequint 17y ago
        That analogy doesn't work. They were selling bonds to financial professionals, who had to have complicated ISDA agreements to even enter into these purchases. Part of their job is to analyze the assets they are buying. Its reasonable to expect them to do so.
    - btilly 17y ago
      Read the complaint again. Goldman Sachs failed to disclose Paulson & Co's role, and then actively lied to investors about Paulson & Co's net position in the deal. This is material information that was not available to investors in the CDO. Hence the complaint. Edit Got the players wrong. Fixed.
    - jamiequint 17y ago
      @btilly (won't let me reply directly to your comment) I realize what you're saying is true, but most of the arguments being made are about being made about whether the trade itself (under normal circumstances) were unethical, I'm trying to counter those.
- btilly 17y ago
  The counterparties had access to all the same info Paulson & Co. did, they just didn't analyze it correctly or in as much detail. You have to separate issues here. Paulson & Co. were counterparties on a credit default swap with Goldman Sachs. That is fine. Goldman Sachs failed to disclose information to investors about Paulson & Co's role, and lied about their position. That is what the SEC is upset about. You are right that the credit default swap was a zero sum bet between equally informed counterparties. It so happens that one side analyzed the deal better. (Actually that is questionable. The bankers on the Goldman Sachs side knew that they would get large personal bonuses no matter what happened to Goldman Sachs. So they may have analyzed it correctly and done what was in their best interest. But let's not get into perverse incentives.) The issue that the SEC has with the scenario is that not only did Goldman Sachs fail to disclose Paulson & Co's involvement (instead saying that ACA had selected all of the bonds), they told investors that Paulson & Co had $200 million in equity in the deal, without disclosing the credit default swap position that meant Paulson & Co were actually significantly net short. This was a lie, and that is why Goldman Sachs is in trouble here. Edit I had the parties wrong. Fixed.
  - jamiequint 17y ago
    OK, yes there was clear misrepresentation of who put together the CDO, that seems to be obvious from the available information. What I just don't see is why it that is material. By nature of buying a Synthetic CDO the buyers had to know someone was short, why should it matter who it was? They should have been buying based off the assets in the investment not based off of the counterparty.
    - dandelany 17y ago
      > By nature of buying a Synthetic CDO the buyers had to know someone was short, why should it matter who it was? Because the party who was short on the product was the same party who created the product, and Goldman did not inform investors of this fact. It's not a matter of just buying and selling. The RMBS's underlying the CDO were packaged by a party who had significant interest in seeing the package blow up. An Oversimplified Analogy: Imagine that I come to you and say, "I have a document that represents 100 mortgages and I'd like to broker a sale. If you buy this document, as long as less than ten of these mortgages go into default, you make money. If more than ten of them go into default, your counterparty in the sale (not me) will make money." "Okay," you say, "that sounds interesting. So where did all these mortgages come from?" "Oh, we got an independent company to pick a bunch of mortgages that they consider fairly safe and that they believe are a good representation of the overall U.S. mortgage market." "Great!" you say, and you buy a billion dollars worth. More than ten mortgages end up defaulting and you lose a shit ton of money. Imagine your dismay when you learn that the mortgages were not packaged by some third party as I claimed, but hand-picked by the very counterparty you were betting against. OBVIOUSLY if they were going to benefit from more than ten mortgages defaulting, they would have filled the entire document full of mortgages they expected to fail! This is fraud in its most basic form!
byrneseyeview 17y ago
So? When buyers push a deal, they design it so it's underpriced. When sellers push a deal, they want it overpriced. In other words, everyone is in this market to profit. You're acting like the motives are criminal, here. But if two people take opposite sides of the same trade, they will both have the sinister motive of picking the other side's pocket. That's why there's a big, detailed disclosure agreement. You can read it right here: http://tinyurl.com/y7rnyh3 http://tinyurl.com/y7rnyh3 . The lock/burglar analogy is flawed, because stealing destroys wealth. Inefficient asset allocations destroy wealth, and asset allocations can only be efficient when people with the same data and different interpretations are able to trade.

lhuang 17y ago

The SEC alleges that GS committed fraud by not informing investors that the "3rd party objective manager" who cherry-picked the assets that were packaged in the CDO was at the same time betting against the very assets he picked. That, and recorded conf calls show that GS analysts as trying to convince rating agencies to inflate the ratings of the underlying assets in the CDO.

nearestneighbor 17y ago
> That, and recorded conf calls show that GS analysts as trying to convince rating agencies to inflate the ratings of the underlying assets in the CDO. What happened to winking, nods and understanding looks on golf courses?
byrneseyeview 17y ago
That's just plain stupid. If you're buying, don't count on the seller having your interests at heart. That's part of Goldman's job. They want the transaction to happen; if they can get a good rating, they should. The entity that's responsible for making the rating agencies rate things well is... the rating agency.
- deleted 17y ago
  [deleted]
- dandelany 17y ago
  There is a massive difference between expecting the seller to have your best interest at heart, and expecting that the seller will give you accurate information regarding what product they are selling you. The first is naivete. The second is Federal securities law.

billjings 17y ago

If this is indeed similar to the ProPublica report (referenced in another post in this thread), then this isn't a case of someone in the "opposite side of a trade". The trade would not have existed without the hedge fund committing to buy the worst parts of it - the party buying the worst tranche was called the "sponsor" for a reason. Not only that, but the sponsor wasn't short on just their portion of the trade. They were short on the entire CDO. They've got a bet that pays off if you crap out. Without that bet, you don't even get the prospectus - you don't even know about the security in the first place. I recommend reading the ProPublica article.

byrneseyeview 17y ago
I've read the ProPublica article. This is even more of a stretch. Deals exist when there is demand on both sides. There can only be demand for both sides of the deal when there's disagreement about how the deal will perform. Goldman is being sued because one of their customers was right, and one of their customers was wrong. If the mortgage bubble had not collapsed, would credit default swap sellers and CDO buyers be penalized for profiting from the shorts' demise?
- siavosh 17y ago
  The issue wasn't a disagreement in valuation, this is totally valid as you point out. The fraud allegation is because they were an advisor to their clients, and supposedly they misrepresented the valuation of products when then knew the value was something else.
- billjings 17y ago
  If they had misrepresented their deal, then yes. If Goldman Sachs lied about matters material to the valuation of the deal then they've committed fraud.
- prodigal_erik 17y ago
  Deals also exist when the parties have different risk tolerances or time preferences for money. If I sell you my car because I need a down payment for a condo, that doesn't mean I think the car isn't actually worth what you're paying. If I know it isn't worth what you're paying because evil mechanics swapped all the working parts with bad ones, and I hide that from you, that's fraud.